"The Honorable Edward J. Markey
United States Senate
218 Russell Building
Washington, DC 20510-2107
Dear Senator Markey:
Thank you for your January 23, 2014 letter requesting that the Securities and Exchange
Commission (the "Commission" or "SEC") investigate the business practices of Herbalife, Ltd. to
determine whether it is acting in accordance with the federal securities laws. In particular, you
raised concerns over reports that Herbalife may be a pyramid scheme.
The Commission's investigations are confidential, and the Commission generally neither
confirms nor denies the existence of an inquiry or investigation unless and until made a matter of
public record in proceedings instituted before the Commission or in court. We do this to protect the
integrity and effectiveness of our investigative process and to preserve the privacy of the individuals
and entities involved. Accordingly, we cannot comment on whether SEC staff has investigated, or
is currently investigating, matters related to Herbalife. Nonetheless, we appreciate your letter and
the concerns you raised. I can assure you that we are giving your concerns every consideration.
In your letter, you asked for information in response to several questions. While specific
responses are provided below, it is important at the outset to note some general information
regarding the Commission's authority to enforce the federal securities laws as they relate to illegal
pyramid schemes and legitimate multi-level marketing ("MLM") companies.
The Commission's Division of Enforcement is responsible for investigating possible
violations of the federal securities laws, including unregistered offers and sales of securities and
false and misleading statements in connection with the offer, purchase, and sale of securities. The
antifraud provisions of the federal securities laws prohibit fraud, in the offer or sale, or in connection
with the purchase or sale, of securities. "Securities" include, among other things, a company's stock
and investment contracts offered by a company or promoters. Generally, the Commission's
jurisdiction is limited to investigating and prosecuting misconduct involving securities as defined by
the law and interpreted by the courts.
The Division of Enforcement regularly investigates the accuracy of disclosures by
companies that offer or sell securities. In these cases, Enforcement staff reviews corporate
statements, whether found in SEC filings, in statements by corporate officers, or elsewhere, to
investigate whether such statements are materially false or misleading. For example, the Division
may investigate whether a company or others misrepresented the company's business as having
attributes of a legitimate MLM company when, in fact, the company does not have those attributes.
The Honorable Edward J. Markey
The Division of Enforcement also regularly investigates whether promoters offer or sell
securities, and, if so, whether the offerings of securities are registered with the Commission in
accordance with federal securities laws and regulations. In these offering cases, SEC staff reviews
the representations made by the promoters to determine whether the interest offered is a security.
For example, the Division may investigate whether promoters offered and/or sold to investors
securities in the form of investment contracts. Under certain circumstances, an interest in a pyramid
scheme may be an investment contract, and, therefore, a security subject to the Commission's
jurisdiction. Whether an interest is an investment contract depends on the particular facts and
circumstances as applied to the law. The Supreme Court has defined an "investment contract" to
include the investment of money in a common enterprise, with the expectation of profits derived
solely from the efforts of others. SEC. v. W.J. Howey Co., 328 U.S. 293,298-299 (1946).
In the securities law context, a so-called "pyramid scheme" is not a defined term, but rather
generally refers to a type of scam in which fraudsters may pitch as legitimate a business opportunity
in the form of MLM programs. SEC staff has issued an investor alert to warn the public of these
scams, titled Beware of Pyramid Schemes Posing as Multi-Level Marketing Programs, available at
pyramid.htm. In this alert, the staff warns that pyramid schemes
masquerading as MLM programs may violate the federal securities laws, such as laws prohibiting
fraud and requiring the registration of securities offerings and broker-dealers. The alert explains
that, in a typical pyramid scheme, money from new participants is used to pay recruiting
commissions to earlier participants —just as in classic Ponzi schemes, where money from new
investors is used to pay fake "profits" to earlier investors. Recently, the Commission has sued
alleged operators of large-scale pyramid schemes for violating the federal securities laws by falsely
representing these scams to be legitimate MLM programs. For example, in SEC v. CKB 168, 13
Civ. 5584 (E.D.N.Y. 2013), Lit Rel. No. 22846 (Oct. 17, 2013),1 the Commission filed charges to
stop an alleged pyramid scheme. In addition, in an adjudicated settled action, SEC v. Rex Venture
Group, 12 Civ. 519 (W.D.N.C. 2012), Lit Rel. No. 22456 (Aug. 22,2012),2 the Commission shut
down a $600 million fraud that duped approximately one million Internet customers through a
complex investment scam involving a Ponzi scheme promoted as a daily profit-share pool and a
pyramid scheme pitched as a legitimate MLM company.
In addition to the SEC's efforts, other federal agencies also seek to combat illegal pyramid
schemes. See, e.g., Multilevel Marketing | Consumer Information
FTC's use of federal consumer protection laws to combat pyramid schemes) and
(listing pyramid schemes as a common scheme that the FBI
With this general information in mind, below are responses to your specific questions.
1) There is a great deal of opacity surrounding Herbalife's system of compensation.
a) Typically, how many compensation system levels do multi-level marketing
companies have? Is it common to see a multi-level marketing company have
1 See http://www.sec.gov/litigation/Iitrel...13/lr22846.htm
2 See https://www.sec.gov/litigation/litre...12Zlr22456.htm
The Honorable Edward J. Markey
more than a half-a-dozen? Also, how many compensation system levels does
the typical pyramid scheme have?
b) Hypothetically, if an entity had a turnover rate in excess of 5% each quarter in
its lowest tier, would that be grounds for an investigation into whether the
entity is a pyramid scheme? What if the turnover rate was in excess of 10%?
What if it was in excess of 50%?
The SEC does not maintain specific data regarding the typical number of compensation
levels or turnover rates at either MLM companies or pyramid schemes. As stated above, the
Division of Enforcement's investigations include disclosure and offering cases, and each
investigation depends on its particular facts and circumstances. In disclosure cases, we investigate
whether any statements made about the business are materially false or misleading, including
statements regarding the compensation levels or the turnover rates. In offering cases, we investigate
whether the interest acquired by the investor was a security, and the compensation level and/or
turnover rate might be relevant to that analysis. However, compensation and turnover rates would
be but two of multiple facts and circumstances used to determine whether Enforcement should
conduct an investigation.
2) How a company structures its operations typically provides insight into whether a
company is a pyramid scheme.
a) Is it accurate to state that the more complex a structure and the longer it takes
to rise through it, the more likely it is a company is a pyramid scheme?
b) Can you provide me with information about the pyramid schemes that the
Commission has prosecuted with the least complex structures, including
information about the minimum amount of time it took a distributor who
entered an entity to rise through each of the entity's compensation levels?
Whether a firm is operating an illegal pyramid scheme in violation of the federal securities
laws depends on the particular facts and circumstances, including the complexity of its structure and
its disclosures concerning the structure. Although we do not have detailed information on the
minimum amount of time for distributors to rise through compensation levels, the following
Commission enforcement actions exemplify pyramid schemes involving limited complexity: SEC
v. Universo Foneclub Corporation, 06 Civ. 109040 (D. Mass.), SEC Lit Rel. No. 19715 (Jun. 1,
2006) (two levels);3 SEC v. Lane, 07 Civ. 1920 (M.D. Fla.), SEC Lit Rel. No. 20393 (Dec. 11,
2007) (four levels);4 and SEC v. West, 09 Civ. 1419 (M.D. Fla.), SEC Rel. No. 21182 (Aug. 21,
2009) (four levels).5 In each action, the defendants purported to operate legitimate MLM
3 See http://www.sec.gov/litigation/litreleases/2006/lr
4 See Robert E. Lane, Wealth Pools International, Inc., and Recruit for Wealth, Inc., Defendants, and T-N-T Education Company, Inc., Richard H. Lane, Mundo Trade, Inc., Renee Becker, Julia Lane, and First Fiduciary Business Trust, Relief Defendants: Lit. R
5 See https://www.sec.gov/litigation/litre...09/lr21182.htm
The Honorable Edward J. Markey
3) There have been inconsistent estimates of sales outside Herbalife's distributor network
(i.e. to people who are not distributors). Typically, the more sales occur within a
distributor network in which the products are not purchased by those who would be
expected to ultimately consume them, the more likely a company is to be a pyramid
a) Have you investigated the fact that Herbalife's statements changed materially
over time about the percentage of sales outside the network?
i) May 1,2012 Conference Call - Pres. Des Walsh: 70% or higher
ii) May 2,2012 - 8K: We don't keep track
iii) Dec. 19,2012 - CEO Michael Johnson: 90% of customers are outside
the network - "Absolutely"
b) Do you have any idea what the accurate number of sales outside the networks
as a percentage of total sales was for each of the last five years?
As stated above, the Commission's investigations are confidential and the Commission
generally neither confirms nor denies the existence of an inquiry or investigation unless and until we
bring charges against someone involved. Accordingly, we cannot comment on whether the
Commission has investigated, or is currently investigating, matters related to Herbalife.
Thank you again for your letter Please do not hesitate to contact me at (202) 551-2100, or
have your staff contact Tim Henseler, Director of the Office of Legislative and Intergovernmental
Affairs, at (202) 551--2010, if you have any questions or comments.
• v —
Mary Jo White